Fundamentals of Corporate Finance

Lecture Overview

• Annual Report: Overview of key financial statements.

  

• Ratio Analysis: Techniques for analyzing firm performance through financial ratios.

• Du Pont Identity: An approach to break down Return on Equity (ROE).

• Using Financial Statement Information: Strategies for analyzing financial data over time and against peers.

The Annual Report

• Key Components:

  • Statement of Financial Position (Balance Sheet): Snapshot of financial standing at a specific time.

    • Assets: What the firm owns (e.g., cash, inventory).

    • Liabilities: What the firm owes (e.g., debts, obligations).

    • Equity: Difference between assets and liabilities.

  • Income Statement: Measures firm performance over a period.

    • Revenues: Income earned from business activities.

    • Expenses: Costs incurred in earning revenues.

  • Statement of Cash Flows: Shows cash inflows and outflows during a period.

    

Statement of Financial Position

• Equation: Assets = Liabilities + Shareholders' Equity

  • Assets: Represent investments made by the company.

  • Liabilities and Equity: Indicate how those investments are financed.

• Components:

  • Current Assets: Cash, accounts receivable, inventory (used within a year).

  • Non-Current Assets: Property, plant, equipment, intangible assets.

  • Current Liabilities: Obligations due within a year.

  • Non-Current Liabilities: Long-term obligations due later.

• Net Working Capital: Current Assets - Current Liabilities.

  • Important for ensuring enough cash is available to pay off liabilities.

    

Book Value vs. Market Value

• Book Value: Recorded historical cost of an asset, adjusted for impairments and depreciation.

• Market Value: The price attainable by selling the asset in the market; can fluctuate based on demand.

  • Example:

    • Machine bought for £100,000 with £20,000 depreciation.

    • Current market price of £90,000 leads to:

      • Net Book Value = £100,000 - £20,000 = £80,000.

      • Profit = Market Value - Book Value = £90,000 - £80,000 = £10,000.

  

Income Statement

• Purpose: Measures performance over a specific timeframe.

• Components: Revenues, Expenses, and Net Income calculation.

• Analysis Techniques:

  • Trend Analysis: Comparison of line items across multiple periods.

  • Ratio Analysis: In-depth evaluation through calculated ratios.

The Cash Flow Report

• Importance: Indicates financial health through cash management.

• Components:

  • Operating Activities: Cash flows from business operations.

  • Investing Activities: Cash flows relating to the acquisition or sale of assets.

  • Financing Activities: Cash flows relating to borrowing and repaying debt, or issuing equity.

  

Ratio Analysis

• Purpose: Analyze and compare financial performance.

• Types of Ratios:

  • Liquidity Ratios: Assess short-term financial health.

    • Current Ratio, Quick Ratio, Cash Ratio.

      
    

  • Leverage Ratios: Measure debt levels relative to equity.

    • Total Debt Ratio, Debt-to-Equity Ratio.

      
    

  • Turnover Ratios: Evaluate efficiency.

    • Inventory Turnover, Total Asset Turnover.

      
    

  • Profitability Ratios: Assess company efficiency in generating profits.

    • Profit Margin, Return on Assets, Return on Equity.

      
    

  • Market Value Ratios: Evaluate stock performance.

    • Earnings per Share, Price-Earnings Ratio.

      

The Du Pont Identity

• Overview: A tool to analyze and improve Return on Equity (ROE).

• Components:

  • Profit Margin: Net Income/Sales.

  • Total Asset Turnover: Sales/Total Assets.

  • Financial Leverage: Total Assets/Total Equity.

• Formula: ROE = Profit Margin x Total Asset Turnover x Equity Multiplier.

  

Using Financial Statement Information

• Trend Analysis: Evaluates the same ratio over multiple years.

• Peer Group Analysis: Compares a firm’s ratios with those in similar industries.

• Aspirant Analysis: Compares with top-performing firms in the sector.

• Financial Planning: Long-term planning through financial statements and sale percentages.